Marsh & McLennan President & CEO Dan Glaser said it plainly during the insurance, reinsurance broking and advisory giants Q2 earnings call. In a soft market insurance and reinsurance firms are likely to keep underwriting even when returns are below their cost-of-capital.
It sounds unintuitive, perhaps crazy to some. Why continue to put capacity at risk when the returns are no longer supportive of the ongoing maintenance of the capital backing it?
The answer of course lies in the insurance and reinsurance industries reliance on long-term relationships and diversification. Those two factors mean that re/insurers will continue to underwrite in regions where others, for example ILS funds with their minimum return requirements, cannot.
Relationships mean insurance and reinsurance firms are bound to continue servicing their cedents, at least the cedents considered the good ones, as breaking the long-term relationship could result in ceding companies finding other tools to manage and transfer their risks.
Diversification means re/insurers can continue to maintain a foothold in the softest of market conditions, as they can offset underwriting at levels below their cost-of-capital against areas of the market where profits are still to be found.
Investments was another factor, as investment returns could in the past have been used to offset technical underwriting profit declines. However, in this world of negative interest rate policy, or zero interest rate policy, the future returns on assets for reinsurers are likely to be thin.
Dan Glaser, President and CEO of Marsh & McLennan, the parent company to insurance brokerage Marsh and reinsurance brokerage Guy Carpenter, said that continuing to deploy capital at diminishing returns is an expected trait of the industry.
Glaser explained the current state of the reinsurance market, saying; “On the reinsurance side, we are beginning to see some moderation in rate declines, especially in U.S. pricing.”
He went on to say that while catastrophe losses have been seen to rise by around 40% in the first-half of 2016, they remain within expectations and pressure is maintained by high levels of capital and surplus, while at the same time reserve releases are diminishing.
“All together, this translates into returns likely below the cost-of-capital, net of reserve releases, for a large portion of the P&C industry,” Glaser continued. “We would expect this to ultimately stabilise pricing, though it may take some time.”
“We don’t anticipate industry pricing dynamics changing anytime soon,” he cautioned. “As history has shown us, some insurers will continue to write business at lower returns in declining rate environments, and in fact will actually write more new business when rates are falling, than when rates are rising.”
Glaser went on to explain that while there is ample capital available to make insurance and reinsurance placements cheaper, there is also an opportunity for markets to add value for clients as well.
“Success in our industry is increasingly based on delivering what matters to clients. Service, breadth of products, coverage innovation, contract certainty, claims performance, responsiveness and competitive pricing,” Glaser said.
“Even in this tough market environment, underwriters continue to offer new products and services that meet the growing risk needs of our clients. This bodes well for our industry to grow and enhance the value we deliver.”
This is perhaps one way that re/insurers can counter the impact of softer pricing, and push up their overall earnings over the life-cycle of a client relationship, even if their capital is deployed at increasingly low levels of return. As recouping some of the return through value add is a sensible way to also keep underwriting capacity efficient.